Focus on Short Term Hurts Companies
Originally posted in the Wall Street Journal on October 30, 2009.
We have passed through the eye of the worst financial storm in 80 years, but now we have to deal with the devastation left behind. In its wake the Great Recession destroyed trillions in economic value and left 25 million Americans, or 17 percent of the work force, without full-time jobs.
Those who fear a repeat crisis are right to be concerned. We have endured similar crises before like the savings and loan debacle, the collapse of Long-Term Capital Management, and the dot com implosion. Unfortunately, Wall Street ignored these lessons and recreated the short-term practices leading to the 2008 financial meltdown.
To prevent recurrence, we cannot just pass quick-fix solutions. Measures like regulating executive pay merely treat symptoms of larger problems, and may distract us from actions required to rebuild a sustainable economy.
This crisis wasn't caused by subprime mortgages; it was caused by subprime leadership. Its root cause is leaders who practice short-termism. The culture of short-termism—investing for short-term gains at the expense of long-term accumulation—has taken hold on Wall Street. Managerial capitalism has replaced financial capitalism as holding periods for stocks dropped from eight years in the 1960s to as low as six months today.
Warren Buffett once said that the best holding period is "forever." That philosophy earned him $40 billion and the reputation as America's best investor. Unfortunately, long-term value investing is decidedly out of favor these days. Instead, investors pursuing short-term returns pressure corporate leaders to meet quarterly expectations rather than creating long-term sustainability and growth.
Many corporate leaders fell prey to playing this short-term game. They bought into the widely-believed myths that a company's stock price represents its true economic value and that success can be measured by comparing quarterly earnings to security analysts' expectations.
They hyped their stock prices with short-term actions or made value-destroying acquisitions that crimped their long-term competitiveness, often putting their entire business at risk. Many of their firms, like General Motors, AIG and Citigroup, are barely surviving now.
According to a McKinsey study, 65 to 70 percent of mergers and acquisitions destroy shareholder value. But CEOs seeking quick fixes for long-term strategic problems often ignore these statistical realities.
No sooner do companies complete their merger binges than activist investors buy small ownership positions to pressure management into spin-offs, divestitures, or other balance sheet chicanery. By this time the companies are so loaded down with debt and pressured to meet quarterly earnings expectations that they abandon their strategies and spin off the lifeblood of their businesses.
Harvard University Professor Michael Porter, the world's leading academic strategist, noted recently, "Capital markets can be toxic to strategy." Porter argues that creating economic value is not the same as creating shareholder value because it requires focus on strategic growth instead of short-term earnings. The Aspen Institute echoes this sentiment. It recently issued a clarion call for "Overcoming Short-termism" that was endorsed by 28 national leaders.
The reality is that it still takes nearly a decade to create lasting shareholder value through breakthrough new products like blockbuster drugs, innovative distribution networks like Wal-Mart and Starbucks, or a values-based, collaborative culture like IBM's.
To prevent future crises, we need a new generation of leaders that recognizes the pitfalls inherent to practicing short-termism. These leaders must be ready for the long-haul effort that is required to create sustainable value, even if they have to constrain short-term results.
I am encouraged that many such leaders are emerging at the helm of major companies and Wall Street firms. Dan Vasella of Novartis and Jeff Kindler of Pfizer are transforming their pharmaceutical firms into 21st century health care leaders, just as Indra Nooyi of PepsiCo and Ken Powell of General Mills are becoming role models for developing sustainable consumer goods companies. Richard Davis of U.S. Bancorp and Jamie Dimon of JP Morgan are demonstrating how banks can balance risk-taking with sound financial management.
If the U.S. wants to be the world's leading economic power, President Obama needs to reinforce a long-term focus by shifting his efforts to building a sustainable economy, rather than bowing to pressures for instant gratification. This means refocusing national priorities on health care innovation, renewable energy sources, high-tech manufacturing, and broadened use of information technology. The government can facilitate this shift with a graduated capital gains tax favoring long-term investments and start-up companies, increased permanent R&D tax credits, expanded investment tax credits, and skills-based retraining programs.
Then a new generation of corporate and Wall Street leaders, supported by elected leaders, can build a sustainable economy that creates wealth and jobs for all Americans.